Sponsor

Sponsor

Fed cuts key interest rate to record low

In a radical move, the Federal Reserve slashed its key interest rate to a record low on Tuesday and vowed to use all the weapons at its disposal to fight the worsening recession, which has dragged down consumer prices and home construction.

The Fed created a new target range for its federal funds rate so that it will hover between 0.25 percent and zero. That dramatically lowers the Fed's targeted rate, called the federal funds rate, which had stood at 1 percent.

The bold move surprised economists, most of whom were predicting the Fed would cut the funds rate in half to 0.50 percent. A few thought the Fed could opt for an even more forceful action. The funds rate is the interest banks charge each other on overnight loans.

Ben BernankePhoto by Alex Wong/Getty Images

With the Fed's key rate dropping to rock-bottom levels, the central bank is moving into uncharted territory.

Nonetheless, Fed Chairman Ben Bernanke and his colleagues made clear that the central bank isn't running out of ammunition to fight the worst financial crisis since the 1930s. It is exploring using tools - other than rate cuts - to revive the economy.

"The Fed will employ all available tools to promote the resumption of sustainable economic growth," the Fed said.

On Wall Street, that pledge sent stocks soaring. The Dow Jones industrials jumped about 210 points in afternoon trading.

Consumer prices fell by a record amount in November, while home building plunged by the most in a quarter-century, according to government reports released Tuesday that underscored the economy's weakening state.

Falling prices for goods and services at first might sound like a good thing. But if prices keep spiraling downward, they can wreak economic havoc. That gave the Fed another reason to lower rates, which would protect against this risk.

Highlighting the toll of the financial turmoil: Goldman Sachs Group Inc. reported its first quarterly loss since it went public in 1999, and rates on 30-year Treasury bonds briefly dipped to a record low of 2.91 percent as nervous investors' flocked to a safe haven.

The benefit of another Fed rate reduction, though, may be mostly psychological, rather than economic.

"It's a feel-good thing," said economist Ken Mayland, president of ClearView Economics. "Hopefully this a bridge to better confidence."

Slammed by the financial crisis, worried banks have hoarded their cash and been extremely reluctant to lend money to customers. Fearful consumers, watching jobs vanish and their investments tank, have sharply cut back their spending, including on big-ticket purchases like homes and cars that typically involve financing.

In response to the Fed's expected action, the prime rate - now at 4 percent - for many consumer and small-business loans also should move lower. The prime lending rate is used to peg rates on home equity loans, certain credit cards and other consumer loans. Cheaper rates could give pinched borrowers a dose of relief.

The goal of lower borrowing costs is to entice people and businesses to spend more, which would revive the economy. So far, though, the Fed's aggressive rate reductions have failed to stabilize the economy.

The Fed said it is weighing other ways to aid the economy.

For example, the Fed could buy longer-term Treasury or agency securities on the open market in substantial quantities. This might lower rates on these securities and help spur buying appetites.

A Fed program announced late last month to buy $600 billion in debt and mortgage-backed securities from mortgage giants Fannie Mae and Freddie Mac already has helped pushed mortgage rates down.

By boosting the quantity of money in the financial system, the Fed has engaged in so-called "quantitative easing" to provide economic relief. The Fed's balance sheet has ballooned to $2.2 trillion, from close to $900 billion in September, reflecting efforts to mend the financial system.

"Never in the postwar history has the Fed acted as lender of last resort to this degree," Mayland said.

In fact, with all the lending by the Fed, the actual funds rate has fallen at times well below its current 1 percent target.

President-elect Barack Obama said Tuesday the Fed is "running out of the traditional ammunition" to fight the recession and that it was critical for other branches government to "step up." Obama, whose economic team is meeting Tuesday, is working on a "bold agenda" to spur an economic recovery.

Hours before the Fed's announcement, the Labor Department reported that consumer prices fell by a record 1.7 percent in November as energy prices retreated. It marked the second straight month that prices dropped and raised the specter that the country could be heading for a dangerous bout of deflation.

Deflation means a widespread - and prolonged - decline in prices that hits Americans' incomes and corporate profits, as well as already stricken housing values and investments. Lower rates by the Fed would help fend it off.

However, the White House welcomed the drop in energy prices, which had soared to record highs in July. "It gives families more cash to spend on other priorities," said spokesman Tony Fratto.

Another report underlined the housing market's woes. The number of housing projects started in November plunged by 18.9 percent, the most in a quarter-century as builders slashed production, the Commerce Department reported. That left housing starts at just 625,000, on an annualized basis, a new all-time low that broke last month's record.

Shell-shocked employers axed 533,000 jobs in November alone. That drove the unemployment rate up to 6.7 percent, a 15-year high.

Since the start of the recession, the economy has shed nearly 2 million jobs. Analysts predict another 3 million more will be lost between now and the spring of 2010.

Last week alone, Bank of America Corp., tool maker Stanley Works and Sara Lee Corp., known for food brands such as Jimmy Dean and Hillshire Farm, announced job cuts.

General Motors Corp. and Chrysler LLC, are in danger of running out of money within weeks and are seeking government aid. The White House is exploring ways to throw a lifeline to Detroit after rescue efforts collapsed in Congress.

With the employment market eroding and consumers retrenching, the economy could stagger backward at a shocking 6 percent rate in the current October-December quarter, analysts predict. It shrank at a 0.5 percent pace in the third quarter.

Obama is advocating an economic recovery plan that includes spending on big public works projects to bolster jobs. His plan also includes tax cuts to spur consumers to spend more and businesses to step up investment and hiring.